We’ve all read it somewhere. Those simplistic anecdotes that say “If Johnny started investing x dollars per year at age 25 he would have over 14 bajillion times as much at age 75 as Susie, who saves 2x dollars per year starting at age 45.” Even though the numbers used in those little illustrations are a bit unrealistic and the IRA rates of return sometimes border on the absurd, the basic principal certainly rings true. That is, opening an IRA with your very first paycheck is the best Roth IRA advice you’ll probably ever receive.
The Magic Of Compounding
Benjamin Franklin once said* that “compounding is the 8th wonder of the world.” Well, I’m not sure if it’s on par with the pyramids or the grand canyon, but the effects of compounding over long periods of time are astounding.
Consider the case of the original Dutch settlers who bought the island of Manhattan from a native American tribe for the equivalent of about twenty-four dollars worth of beads and glass. What a bunch of suckers! The value of Central Park alone is probably in the billions of dollars these days, not to mention the value of all the real estate on the rest of the island (For the record, the assessed value of all the real estate in Manhattan was valued at about $45 billion in 1991).
But as fate would have it, it is the Dutch who were actually the suckers. If the Dutch had taken that $24 and invested in in the stock market at its (recent) average rate of return of 10% per year for 350 years, that portfolio would now be worth over 100 trillion dollars! For the liberal arts majors in the audience, $100 trillion is greater than $45 billion. Okay, so there was no stock market back then for the Native Americans to invest in and if there was, they probably wouldn’t have earned 10% per year for 350 years. But it just goes to show that over a long enough period of time, even a small amount of money can turn into a large amount of money. Think you can put off saving for retirement for another 10 years? Just think of that poor Dutch schmuck who overpaid for Manhattan real estate and missed out on a hundred trillion dollar fortune.
* Benjamin Franklin probably never actually said that, but it’s a pleasant myth
** This is also not true as far as I can gather
